A local business which has produced a new electronic component have received a large order from a major company in the electronic industry and they anticipate substantial profits.

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NAME: SARBJIT SINGH SANGHA               HND BUSINESS & MANAGEMENT

MODULE: MANAGEMENT ACCOUNTING ASSIGNMENT 5 BUDGETING

Scenario 1

A local business which has produced a new electronic component have received a large order from a major company in the electronic industry and they anticipate substantial profits.

The following projected cash flow has been produced for the first six months in which components are to be produced:

The bank has agreed to provide a loan commencing on Jan 1st to be repaid on May 31st. The company anticipates that customers will pay 2 months after the month of sale and suppliers will be paid 2 months after the month of purchase (e.g. the sales of £60,000 were made in January). The company's management is anxious about the loan repayment.

Budgeted Cash Flow Statement

The cash  flow  statement sets  out  the  anticipated cash inflows and cash outflows over the coming months. Each column shows money coming into and out of the business in that month. The cash flow statement takes information from a variety of sources to show an overall picture of the monies flowing into and out of the business during the financial year.

The statement then shows the effect of each month’s cash flow upon the business’s cash balance/total. One essential rule to the cash flow statement construction is that money is shown when it is received or paid. Therefore it is important to emphasise that the profit of the business may be significantly different from the cash flow. The statement is intended to show information that is not available from examining the profit and loss account and balance sheet.

The statement concentrates on liquidity. The cash flow statement shows if there is sufficient cash available each month. Although the company may be profitable in the long-term, in the immediate short-term the company suffers cash flow difficulties as output continues to increase. In the short-term, cash flow plays a vital role and the business does survive without making a profit for some time. It should be noted that for future long-term survival and especially growth, profit is essential.

Note:

The cash flow statement has been based on the assumption that receipts and payments from July to December will be the same as those in the month of June.

Memorandum

To:        Managing Director

From:        Financial Consultant

Subject: Improvements on Cash Flow Projection.

Clearly, the arranged bank loan will be sufficient to meet the cash flow requirements of the business. Armed with the cash flow information, the bank loan could perhaps be re-negotiated, or timing changes could be made to the payments. Capital expenditure could also be spread throughout the year.

The healthy cash surplus of £450,000 in December leaves the business with a favourable cash position at the end of the budget period. The bank loan re-payment in May leaves a negative bank balance at the end of the month of £40,000 which is carried forward into the following month.

As the bank loan re-payment in full predicts a negative cash balance in the month of May and is the only source of finance in at the beginning of the budget month, the business can take actions to avoid such problems. It can do this in several ways:

Speeding up cash inflows: This can be done by:

  • Negotiating shorter credit for customers: if customers agree to pay for the goods earlier, cash is received earlier. In a very competitive market the length of credit may be a competitive issue. Discounts can be offered to encourage early payment of bills. Often, this policy will result in a loss of goodwill and problems with customers. There will also be very little scope for speeding up payments when the credit period currently allowed to debtors is no more than the norm for the industry.  Currently the business allows customers up to two months credit which could be reduced to one month which would considerably help reduce the negative cash balance in the month of May. The business could suffer should customers take there business elsewhere.

  • Credit management:  businesses can improve cash flow by ensuring that payment is received on time. This is likely to involve writing reminder letters and making phone calls to persuade customers to pay promptly. Chasing debtors for early repayment may lead to long term loss of trade, as the debtors may buy from another business next time, but it can be an effective method of solving short-term cash flow problems.

Factoring: It may be possible to factor the debt. By factoring the company is able to receive 80% of the amount due within 24 hours of an invoice being presented. The factor then collects the money from the customer when the credit period is over. And pays the seller the remaining 20% less the factoring fees. These depend on the length of time before the payment is due, the credit rating of the creditor and current rates of interest. The fees are usually no more than 5% of the total value of the sale.

Delaying cash outflows: This can be done by negotiating longer credit for supplies -this postpones cash outflows, which can help the business, get through a difficult period. The length of credit will often depend on the stability of the company. As the business currently pays all its suppliers immediately, creditors may not be reluctant to extend credit. The current re-payment period allowed by suppliers is two months which clearly should not be abused any further. Although the capital expenditure on machinery could be spread throughout the year which would again help reduce the negative cash balance in the month of May.

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It should also be noted that payment to creditors can only be made if debtors pay on time. Should debtors not pay on time the company would be unable to pay off its creditors which could result in possible liquidity difficulties, therefore having a knock-on-effect on the whole of the business operations.

Cutting or delaying expenditure: Ways of decreasing expenditure include:

  • Decreasing levels of stock: often cash flow problems arise because too much capital is tied up in stock. When we talk about stock we mean raw materials, work-in-progress and finished goods. Many firms are now ...

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